Now, it wasn't too much later that I learned that the process actually happened the other way around, but it remains my earliest recollection of learning to distinguish between cause and effect. A relationship that continues to baffle many.
We're seeing an example of it right now in Europe. As the European Union struggles to solve the financial problems of its southern members, a meme has begun to circulate that the European problems aren't cause by debt, but by an undesirable balance of payments.
It is neither positive nor negative for the future of the euro, which is the main issue concerning the markets. In the meantime, the eurozone soldiers on with a plan which policymakers seem to think will restore confidence to markets, but infact has very little bearing on the underlying balance of payments crisis. - Jeremy Warner, Daily Telegraph
We have another euro agreement but one that misses the point. What is going on in the euro area is not a crisis of government profligacy. It is a balance of payments crisis of a fixed exchange rate regime. - Trevor Greetham, Fidelity Worldwide Investment
This is nonsense -- conventionally wise nonsense -- but nonsense nonetheless. This isn't a crisis caused by damaging balances of payments -- those are just symptoms of economic conditions. Ludwig Von Mises wrote:
The imports and exports of money and bullion are viewed as the unintentional outcome of the configuration of the nonmonetary items of the balance of payments. This opinion is utterly fallacious. An excess in the exports of money and bullion is not the product of an unhappy concatenation of circumstances that befalls a nation like an act of God. it is the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead. - [Human Action, Ludwig Von Mises Institute, 1998, pp. 448-449]
It's well understood that, with the advent of the Euro, the Southern Europeans suddenly found themselves holding currency that was at par with the mighty Germans and French. BMW's, Brie and Riviera vacations were all on sale. At the same time, their governments went on a spending binge due to cheap bond rates and tens of thousands were added to already-bloated government payrolls at very comfortable salaries. With cheap prices for foreign goods and an influx of cash into the local economies, Italians; Greeks; Spaniards; and Portuguese (whose money had never been very stable or safe) embarked on a buying spree that resulted in goods trade deficits and negative balances of payments.
Now, the thinking goes, these trade deficits must be reversed: the south must export more and the north (Germany, specifically) must import more to "balance things out". But how is this to be accomplished? What magic wand can the Europeans wave to change the behavior of hundreds of millions of citizens? After all, countries don't trade with countries, people trade with people. And the people of Europe behaved quite rationally given the economic situation.
If the current problems of the Euro-zone are to be fixed, the only solution is to allow interest rates in the south to rise which would curtail government spending and begin to reduce the amount of excess cash (cash not backed up by produced goods) now being spent on imports. This won't be allowed to happen, apparently. In fact, the opposite is taking place. Under severe political pressure, the ECB is being instructed to print even more Euros.
So, in addition to leaving the conditions in place that produced southern Europe's goods deficits, the EU's great desire to inflate their way out of their problems will result in the endangerment of Germany's juggernaut of an export machine. As prices rise in Europe, Germans will find foreign goods increasingly attractive and increase their imports. At the same time, German exporters will have to raise their own prices decreasing their sales abroad.
Chronic trade deficits are caused by monetary inflation and over-valued foreign exchange rates. The lack of one of those can sometimes compensate for the other (see: Japan, lack of inflation, high yen, trade surplus), but the two together are a sure-fire formula for the exact opposite of what the Europeans claim to want. The balance of payments is a result of government regulation and monetary policy. As such, it cannot be the cause of economic problems.
When European trade balances go even further into the red, great consternation will ensue.